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June 12, 2013

Market Holds Rally, Investors Don’t Show Up

Morningstar analysts say advisors need to help their clients maintain discipline, even if that means sub-optimal returns

Is it just your clients who missed the huge stock market rally?

Apparently not, judging from a fund research round table that included top Morningstar analysts Scott Burns, Russel Kinnel, Laura Lutton and John Rekenthaler.

In a free-flowing discussion that is a highlight of each year’s Morningstar Investment Conference, the Chicago-based research firm’s top analysts answered questions from PBS business journalist Consuelo Mack.

Self-defeating behavior on the part of investors was a theme that came up early and often on the late Wednesday panel.

Burns (left) called it “confounding” that a huge segment of investors have not participated in the stock market rally, describing the heavy flow into fixed income as a “retroactive fix” of a bad asset allocation that overweighted stocks prior to the financial crisis.

Rekenthaler’s formulation packed more pain:

“You don’t get too many chances to get over 100% gain without inflation after only four years,” he said, adding that huge numbers of investors compounded the woe of missing the rally by heading for the exits after locking in portfolio losses in 2008 and 2009.

Conversely, Lutton worried about latecomers to the rally, saying “investors chasing performance doesn’t end well historically. Those who see bonds as safe investment are going to be unhappy.”

Missing the rally and coming to it late, with all the dangers that entails, made investment strategy another dominant theme in the discussion.

“This fall it will be five years since [the collapse of] Lehman Brothers,” Burns noted, “but people talk about it as if it were five weeks ago. The scars are still so deep.”

For that reason, he said financial advisors should give serious consideration to strategies that might not be optimal from a return perspective, such as target-date or low-volatility funds.

“If at the end of the day they make the investor behave better, they’re better off [with these strategies]. So many did the wrong thing after 2008-09,” he said.

“The two surest ways to not reach your goals are to not save and leave it all in cash,” he added. For advisors, therefore, the challenge is to “keep in the game but in a way that the client can tolerate.”

For Kinnel’s part, “cost and stewardship are the biggest factors FAs should consider in investing clients’ dollars.”

Stewardship, which looks at things such as the culture of the fund firm and whether managers invest in their own fund, was also emphasized by Lutton.

“Is this fund firm a good caretaker of your capital?" she said. "Studies have shown a relationship between these softer [factors] and performance.”

In that regard, Kinnel noted that “some of the big publicly traded fund firms are less careful” stewards of shareholder capital, but he said boutique firms could be found on either extreme, noting that the boutique firm Strong Funds got caught in scandal whereas Vanguard got to where it is through its fund stewardship.

And Burns steered away from large vs. small, saying [bond giant] “PIMCO, at end of the day, is one big boutique—they’re not all things to all people.”

When asked by Mack to name names, Kinnel cited FPA Capital, Primecap and TFS as excellent fund companies.